Moral hazard is clue to solving euro crisis

By Hugo Dixon

May 20, 2011

By Hugo DixonThe author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — Moral hazard is the clue to solving the euro crisis. The idea that entities don’t learn lessons unless they feel pain is valid in the euro zone — but only if the blame is shared properly. The mess isn’t just the responsibility of profligate Greeks, but also of foolish banks and hypocritical Germans and French. Each needs to suffer.

One of the main reasons the region’s financial crisis is so intractable — with endless wrangling over what is the best way forward — is because the different players haven’t fessed up to their own sins. There is therefore a tendency to proclaim their own virtue and pin the blame on others. This makes it hard to come up with a fair settlement.

The main fault line is over whether it is the borrowers (Portugal and Ireland, as well as Greece) who were to blame or the lenders. If, like the German tabloid press, one thinks that it is just the borrowers’ fault, the natural remedy is to crack down on them by imposing stringent austerity programmes in return for bailouts. If one is too lax, they will sin again.

But the lenders were also foolish. That’s something the population in peripheral countries, especially Ireland, increasingly appreciates. Germany and France, though, whose banks are exposed to the euro zone periphery, haven’t faced up to this truth. This causes its own moral hazard: unless banks suffer write-downs as a result of debt restructuring, how can they be expected to learn the appropriate lessons?

Moral hazard also has a third dimension: the hypocrisy of the big, rich countries. Germany and France were responsible for undermining fiscal discipline early in the millennium by breaking the Maastricht Treaty’s rules on borrowing. It is therefore appropriate that they should suffer too, largely through making more cheap loans to Greece and other struggling countries.

A combination of more austerity, haircuts for creditors and further soft loans from rich countries will probably be what eventually solves the euro zone crisis. But the region would get there faster if everybody admitted their own guilt.

Yes, Mr. Dixon, moral hazard is the name of the game. But don’t confuse the corruption in Greece with the current generosity of the taxpayers in NW Europe to support them through the ECB rescue fund. Making the argument to make those conditions even more generous really sounds stupid when you talk about moral hazard. The taxpayers were simply not in the equation when all this happened. That they are not burning down EU offices in Brussels right now is simply a result of a culturally grown ability to show constraint and patience, which is being tested to the limit right now. I don’t know what the hell would happen when there would be a referendum on cutting the membership of Greece.

Concerning the banks that have lend money to Greece, they indeed have to suffer and I think you are a little behind schedule. The loans are mostly already written off. Market value evaporated and impairment rules are quite clear when it comes to incurring losses. Some of it is sold and I don’t know whoever owns it now. But you can be sure the banks won’t make that same mistake twice. Risk premiums for Greece and Portugal will be high for a decade to come.

This is a permanent rescue mechanism which they are talking about. Permanent rescue mechanisms will also mean automatic mechanisms, thus bailouts would no longer need to be debated in Parliament and tried in the court of public opinion. I suppose the idea is to indoctrinate to masses to believe that this type of behavior is acceptable. Allowing a partner in crime, IE large lending institutions to get away unscathed is an issue, but biting the hand that feeds via forced cheap loans would hurt more than just banks.

This is right. However, when whole governments (eg Greece, Ityaly) cook the books, the lenders are “less to blame” than the borrowers.
Simply making everyone share the blame doesn’t solve the huge problem of Moral Hazard. The show just goes on.
As far as I can see, the idea of a split-Euro had been dismissed as too confusing. But it would answer Mr Dixon’s point; all would share the consequences. But pain would be less. Italy, Greeces etc could work their way out with a weakened currency. The Northern banks would hold a weaker denomination, but money would initially flow in the northern direction (govt officials leading the race, no doubt), so the northern banks would arguably gain and be happier to support a leaner south. The south could, over a number of years, begin to act honestly (ie collect taxes) and a balance would be achieved.
A southern Euro would not be drastically different, and in theory could eventually catch up.

I’d say that the lenders are just as culpable as the borrowers, even when a country has been cooking the books. Everyone knew that Greece was spending much more than it could afford to spend and they lent them money anyway.

A year ago Greece was insolvent, yet it was given more loans, supposedly enough to last two years. Greece is losing ground so fast that the two year money was gone in one year. Yet the EU and IMF are again trying to find a way to loan even more money to Greece.

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